Last Wednesday January 18th the GAO issued its Dodd-Frank mandated Report on “Hybrid Capital Instruments and Small Institution Access to Capital” http://www.gao.gov/products/GAO-12-237 . The Report was addressed to the Chairs and ranking members of the Senate Banking and House Financial Services committees. The Report is remarkable for numerous reasons. I urge you read it and you will see how Washington works(or doesn’t work).

As GAO reports to the Congress, it is not surprising that the Report supports the wisdom of the Collins amendment. It is also not very surprising that the agencies reviewed the draft and evidently didn’t express any opposition to the conclusion therein particularly given that the FDIC was a strong proponent of the Collins amendment. The Report states that GAO consulted with trade associations. The report may well be a prime example of the statistician that drowned wading a stream that averaged 2 feet in depth.

The report studied: 1. the effect of the phase out of hybrid instruments by the Collins amendment and the use by holding companies of Tier 1 hybrid capital instruments their benefits and uses; 2. the effect of excluding Tier 1 hybrid instruments on capital adequacy and international competitiveness; and 3. access to regulatory capital by smaller banking institutions.

With respect to holding companies, the Report’s data relevant to mutual holding companies would be that derived from MHCs with and without stockholders registered as bank and S&L holding companies. However, a reading of the statistical methods employed and the size of the universe suggests these companies were not treated as a statistically relevant subset and therefore no conclusions could be derived as to MHCs with or without minority shareholders. Neither mutuals or MHCs with or without minority shareholders were mentioned. Nonetheless, the broad conclusions of the report did not specifically exclude mutuals or MHCs but purported to apply to all small banks and holding companies. The report failed to mention MHCs as a form of hybrid or the capital they have raised in minority offerings.

With respect to the uses of Tier 1 hybrids the report stated that they were used mostly by the 20 largest bank holding companies amounting to more than $100 billion in assets or 85% of bank holding companies’ Tier 1 hybrid capital. Nonetheless, the GAO acknowledged that holding companies with less than $10 billion in assets held a higher percentage of their capital in Tier 1 hybrids. The study mentions the small bank exemption for bank holding companies stating that the Dodd-Frank Act “largely exempts” institutions with less than $500 million in total capital from the exclusion of tier 1 hybrid capital suggesting that small bank holding companies would not need the hybrid capital. While this is mostly correct it intimates that the statement applies to thrifts as well except in an acknowledgement buried in footnote 33 to its discussion of the use of hybrids by S&L holding companies. It fails to mention or discuss in the narrative that the Collins amendment leaves S&L holding companies at a significant capital disadvantage in that they are not eligible for the exemption as thrifts. It concludes the obvious; that fewer S&L holding companies relied on hybrids TRUPS for Tier 1 capital. It dismisses the fact that S&L holding companies had no consolidated capital requirements by stating that they were informally applied without testing that assumption other than a reference to the OTS exam manual. In other words, the implication is that S&L holding companies other than a few giants were disinterested in hybrids and would therefore be unaffected by their elimination as Tier 1 capital. Again no mention is made of mutual holding companies and no acknowledgement is made that there are MHCs with or without minority shareholders that have raised capital by issuing subordinated debt or TRUPS at the mid-tier level. The report continues to analyze the effect of the elimination by weighing the amount of Tier 1 hybrids included in the prompt corrective action” PCA” compliance categories of capital. It fails to give adequate weight to the agencies’ application of subjective capital requirements based on their risk assessments of individual institutions which often places the amounts required at much higher levels. In its snow globe world of wonder, the GAO uses the 6% risk based capital as a measuring tool concluding that few if any banks or holding companies would fall below the relevant PCA levels by excluding hybrid tier 1 capital. It cites Basel 111 as likely having more stringent requirements but fails to weigh its impact since it is still in the future. This brings the GAO to the startling conclusion of the Report that eliminating Tier 1 hybrids will “likely have limited effects”. It states on page 33; “However, the implied shocks [ of replacing hybrid capital] are relatively small , and the sensitivity of lending activity to changes in capital levels is moderate.”

The last section of the report dealing with small banks finds that small banks generally have limited options for raising capital and one important form of capital TRUPS is now unavailable to them. It acknowledges that, until pooled TRUPS, small banks had few options. It observed the obvious that during and following the financial crisis, offerings of TRUPS dropped considerably. It then goes on to recount all the difficulties in raising capital in a negative market by small institutions . It cites a laundry list of hurdles including skittish investors, market liquidity, regulatory costs, compliance with ownership thresholds, non-deductibility of dividends, disproportionate research burden by investors and the absence of coverage by investment firms and rating agencies. Based on its survey it reports that 88% of institutions surveyed did not declare any need or desire to raise more regulatory capital. Of course, it fails to explore the obvious reasons for such a response i.e. the difficulty of raising common equity or perpetual non-cumulative preferred in the worst bank market since the last depression. Nor does it conclude that the need for bank capital is at an all-time high or that the various restrictions in Dodd Frank some of which it includes in its litany of hurdles need to be changed. More importantly, it completely ignores the Dodd Frank restrictions on dividend waivers and the Federal Reserve Board’s Reg MM member voting requirement.

Given the conclusions reached, mutual holding companies are better off having not been mentioned in the report by name. Nonetheless, the Report does not state that it didn’t survey mutuals. It purports to apply to all holding companies and banks whether they be bank, thrift, mutual or mutual holding companies. The take away for mutual holding companies is that the Report supports a bias for common stock and perpetual stock and dismisses the need or utility for other forms of tier 1 hybrid equity. It appears to be oblivious to the recent burdens on mutuals attempting to issue minority stock or MHCs ability to maintain their status with the Federal Reserve Board’s new restrictions on dividend waivers, Mutual Holding Companies like thrifts in general continue to be lost in the Washington shuffle and attempts to address their access to capital will not be initiated by the regulators or the traditional trade groups for that matter. We will continue to press GAO hard on the Report’s failings . We have already spoken with the Report’s author and corresponded with other GAO staffers to express our concerns.. We believe that inasmuch as the Report demonstrates a bias for perpetual preferred or common equity it supports our case to eliminate burdens on raising that form of equity such as the mutual member dividend waiver burden.

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